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A Candy-Coated Grid

Incentives for transmission investment could boost postage-stamp pricing over license-plate rates.

Fortnightly Magazine - March 2006

regulators to take a broad regional or even national view of the value of a given grid investment. It forces regulators and utilities to think more in terms of moving lignite-fired power from, say, North Dakota to New Jersey, and what that would save in fuel, than in terms of how reducing the chance of an outage in, say, Princeton, would improve quality of life. This broad regional view implies an entirely different set of winners and losers. And it clashes in particular with the needs of state regulators, who modify retail rates only rarely (and then based on zonal averages rather than nodal differentials), and who see the prevention of local outages as the prime directive.

At LG&E Energy, now known as E.On AG, which recently acquired Powergen plc, the parent company of utilities subsidiaries Kentucky Utilities and Louisville Gas & Electric, Vice President Michael Beer commented that the NOPR could clash with state statutes forcing utilities to serve retail native load at least cost, and to invest in transmission not to accommodate wholesale markets or long-distance regional exports and imports, but rather, only if it will serve local needs .

Also, the incentive scheme that EPACT imposes on FERC may well spell the end for the rate design known as license-plate pricing. This pricing design allocates grid expansion costs only to those consumers native to the smaller utility-specific service territory where the investment is located. In that manner, Ohio ratepayers would pay the entire cost of a new 760-kV line designed to help import North Dakota power to New Jersey to help East Coast consumers save money. License-plate pricing famously ignores the benefits that grid expansion can foster between widely dispersed geographic market areas. It spells trouble for any federal policy that awards incentives for investment designed to maximize such efficiencies, but then allocates their costs entirely within narrow boundaries. By contrast, it likely would encourage greater use of postage-stamp pricing, which spreads grid expansion costs across a larger footprint, or some other form of rate design that includes at least some sort of allocation factor that treats the grid as a sort of superhighway, designed for long-haul power movements.

Evidence of this conflict already can be seen building in cases recently pending at FERC that involve allocations of grid upgrade costs within several RTOs.

ROE, Finance, and Capital Structure

Putting aside for the moment the question of cost allocation and pricing for upgrades, the grid-incentive NOPR has revealed a strong industry preference for revamping the discounted cash-flow (DCF) method that FERC now uses to set ROE for transmission owners.

Ameren, Trans-Elect, Progress Energy, Southern California Edison, and others have called on the commission in no uncertain terms either to scrap the DCF method, or at least consider alternatives.

Writing for Southern Company Services, counsel Andrew Tunnell notes a strong disconnect between models such as DCF, founded on identification and calculation of specific variables to explain stock price growth, and what is actually observed in stock markets. He notes also that while FERC’s DCF model often has produced returns under